Beware this TFSA pitfall for young clients

Canadians born in 1992 and later should know that their TFSA contribution room begins to accumulate in the year in which they turn 18, and not the year in which the TFSA program launched.

A person who was 18 years or older in 2009, the year the TFSA was launched, and who has never contributed to a TFSA, would in 2019 have $63,500 in total accumulated contribution room. For 2020, an additional $6,000 will be available, for total contribution room of $69,500 for an eligible person who has never contributed to the TFSA.

However, Canadians born in 1992 and after (and thus who were 17 years old or younger in 2009), and who have never contributed to a TFSA, would calculate their total TFSA contribution room amount by adding up the yearly contribution limits from the year in which they turned 18 onward.

“You do hear people say, ‘The accumulated room for TFSAs [in 2019] is $63,500.’ And that’s correct — as long as you were 18 and over in 2009, when the whole thing got going,” says Doug Carroll, practice lead for tax, estate and financial planning at Meridian Credit Union in Toronto. “Otherwise, you start calculating based on reaching the age of 18, not based on the program coming into existence.”

For example, someone who was born in 1994, and who would have turned 18 in 2012, would have $48,500 in total TFSA contribution room in 2019 if he or she had never contributed to a TFSA. In 2020, with the $6,000 of TFSA contribution room for that year, he or she would have $54,500 if he or she still had never contributed.

Below are the TFSA dollar amounts by year.

For 2009, 2010, 2011 and 2012:         $5,000

For 2013 and 2014:                             $5,500

For 2015:                                             $10,000

For 2016, 2017, and 2018:                  $5,500

For 2019 and 2020:                             $6,000

A TFSA is a tax-sheltered account in which contributions are made with after-tax dollars, but for which withdrawals are tax-free. Any unused TFSA contribution room is carried forward indefinitely, and any withdrawal in a given year is added to the contribution room of the following year.

Canadian residents accumulate contribution room regardless of whether or not they open a TFSA. In provinces and territories where the age of majority is 19, people will not be able to open a TFSA until the year they turn 19. Nevertheless, people in these jurisdictions will carry over the unused contribution room from the year in which they turn 18 so it’s added to the contribution room from the year they turn 19.

“If you get into a routine of setting aside some amount that’s reasonable in terms of your income sources, you can park that amount into a straight savings account,” Carroll says. “Then, when you can legally open the TFSA, you can move that money over from where it was to the TFSA.”

TFSAs may be well suited to younger Canadians, who often earn modest salaries. Low income earners are taxed at lower rates than high income earners, so they don’t receive as much tax relief from making contributions to an RRSP as a high income earner would. In contrast, while the TFSA doesn’t offer a tax break on contributions, it does allow for tax-free withdrawals. Withdrawals from an RRSP are taxable as income.

It’s not uncommon for Canadians to overcontribute to their accounts, typically by withdrawing money and recontributing within the same year in such a way as to exceed the contribution limit for the year. The Canada Revenue Agency (CRA) imposes a penalty of 1% a month on an excess amount over the limit.

Canadians who want to find out their TFSA contribution room can do so via the CRA’s My Account or MyCRA websites, or by authorizing a representative through Represent a Client to do so on their behalf. They can also contact the CRA directly to ask for their TFSA room statement and/or TFSA transaction summary.

However, Canadians would be well advised to keep track of their TFSA withdrawals and contributions themselves “to ensure that they don’t end up in any overcontribution situation, because there can be some delay between when a [TFSA] transaction occurs and when information is reported to the CRA,” says Wilmot George, vice president of tax, retirement and estate planning with Toronto-based CI Investments Inc.